SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------------------------------
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Commission File Number 1-12282
CORRPRO COMPANIES, INC.
(Exact name of registrant as specified in its charter)
OHIO 34-1422570
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1090 ENTERPRISE DRIVE, MEDINA, OHIO 44256
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (330) 723-5082
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES X NO
----- -----
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES NO X
----- -----
As of November 12, 2003, 8,454,847 Common Shares, without par value, were
outstanding. Common Shares, without par value, were outstanding.
1
CORRPRO COMPANIES, INC.
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INDEX
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Page
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PART I. FINANCIAL INFORMATION
- ------------------------------
ITEM 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to the Consolidated Financial Statements 6-15
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16-30
ITEM 3. Quantitative and Qualitative Disclosures
About Market Risk 31
ITEM 4. Controls and Procedures 32
PART II. OTHER INFORMATION
- ---------------------------
ITEM 1. Legal Proceedings 33-35
ITEM 6. Exhibits and Reports on Form 8-K 36
2
PART I. FINANCIAL INFORMATION
- ------------------------------
ITEM 1. FINANCIAL STATEMENTS
- ------
CORRPRO COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
September 30, March 31,
2003 2003
(Unaudited) (Audited)
------------- ---------
ASSETS
Current Assets:
Cash and cash equivalents $ 5,126 $ 7,037
Accounts receivable, net 25,612 18,156
Other receivables, net 1,410 7,192
Inventories 9,217 8,233
Prepaid expenses and other 4,210 3,436
Assets held for sale 7,551 9,846
-------- --------
Total current assets 53,126 53,900
-------- --------
Property, plant and equipment, net 6,853 6,982
Other Assets:
Goodwill 14,205 13,343
Other assets 2,768 3,023
Deferred income taxes 451 482
-------- --------
Total other assets 17,424 16,848
-------- --------
$ 77,403 $ 77,730
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Short-term borrowings and current portion of long-term debt $ 48,405 $ 50,476
Accounts payable 8,976 9,081
Accrued liabilities and other 13,358 12,755
Liabilities held for sale 4,945 3,454
-------- --------
Total current liabilities 75,684 75,766
-------- --------
Long-term debt, net of current portion 649 765
Commitments and contingencies -- --
Shareholders' Equity:
Serial preferred shares -- --
Common shares 2,276 2,276
Additional paid-in capital 46,560 46,560
Accumulated deficit (46,123) (45,076)
Accumulated other comprehensive loss (679) (1,597)
Common shares in treasury, at cost (964) (964)
-------- --------
Total shareholders' equity 1,070 1,199
-------- --------
$ 77,403 $ 77,730
======== ========
The accompanying Notes to Consolidated Financial Statements are an integral part
of these balance sheets.
3
CORRPRO COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
For the Three For the Six
Months Ended Months Ended
September 30, September 30,
----------------------- -----------------------
2003 2002 2003 2002
-------- -------- -------- --------
Revenues $ 34,433 $ 31,473 $ 67,485 $ 61,162
Operating cost and expenses:
Cost of sales 22,938 20,939 44,922 41,092
Selling, general & administrative expenses 7,888 9,115 15,864 18,152
-------- -------- -------- --------
Operating income 3,607 1,419 6,699 1,918
Interest expense 1,609 1,535 3,088 2,819
-------- -------- -------- --------
Income from continuing operations
before income taxes, discontinued operations
and cumulative effect of change in accounting
principle 1,998 (116) 3,611 (901)
Provision for income taxes 655 414 1,008 784
-------- -------- -------- --------
Income (loss) from continuing operations before
discontinued operations and cumulative effect
of change in accounting principle 1,343 (530) 2,603 (1,685)
Discontinued operations:
Loss from operations, net (3,223) (2,828) (3,604) (4,120)
Loss on disposal, net of income taxes -- -- (46) --
Cumulative effect of change in accounting principle -- -- -- (18,238)
-------- -------- -------- --------
Net loss $ (1,880) $ (3,358) $ (1,047) $(24,043)
======== ======== ======== ========
Earnings (loss) per share - Basic:
Income (loss) from continuing operations $ 0.16 $ (0.06) $ 0.31 $ (0.20)
Discontinued operations:
Loss from operations, net (0.38) (0.34) (0.42) (0.49)
Loss on disposal, net of income taxes -- -- (0.01) --
Cumulative effect of change in
accounting principle -- -- -- (2.18)
-------- -------- -------- --------
Net loss $ (0.22) $ (0.40) $ (0.12) $ (2.87)
======== ======== ======== ========
Earnings (loss) per share - Diluted:
Income (loss) from continuing operations $ 0.14 $ (0.06) $ 0.28 $ (0.20)
Discontinued operations:
Loss from operations, net (0.34) (0.34) (0.38) (0.49)
Loss on disposal, net of income taxes -- -- (0.01) --
Cumulative effect of change in
accounting principle -- -- -- (2.18)
-------- -------- -------- --------
Net loss $ (0.20) $ (0.40) $ (0.11) $ (2.87)
======== ======== ======== ========
Weighted average shares -
Basic 8,408 8,403 8,408 8,376
Diluted 9,356 8,403 9,382 8,376
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
4
CORRPRO COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
Six Months Ended
September
30,
-----------------------
2003 2002
-------- --------
Cash flows from operating activities:
Net loss $ (1,047) $(24,043)
Adjustments to reconcile net loss to net cash
provided by (used for) operating activities:
Loss from discontinued operations 3,650 4,120
Depreciation and amortization 1,403 1,487
401(k) matching contribution in Treasury shares -- 136
Pension Accrual adjustment -- 498
European Operation impairment charge -- 450
European Operation currency translation adjustment -- (247)
Deferred income taxes (63) (69)
Cumulative effect of change in accounting principle -- 18,238
Gain (loss) on sale of assets 23 (11)
Changes in operating assets and liabilities:
Accounts and other receivables (1,331) 2,192
Inventories (729) 1,203
Prepaid expenses and other (673) (1,420)
Other assets (429) 175
Accounts payable and accrued expenses 51 1,037
-------- --------
Total adjustments 1,902 27,789
-------- --------
Net cash provided by continuing operating activities 855 3,746
-------- --------
Cash flows from investing activities:
Additions to property, plant and equipment (306) (235)
Proceeds from disposal of property, plant and equipment 74 54
-------- --------
Net cash used for investing activities (232) (181)
-------- --------
Cash flows from financing activities:
Net payments under Revolving Credit Facility and
lines of credit (2,886) (1,807)
-------- --------
Net cash used for financing activities (2,886) (1,807)
-------- --------
Effects on cash of foreign currency exchange rates 216 148
-------- --------
Cash provided by discontinued operations 136 454
-------- --------
Net increase (decrease) in cash and cash equivalents (1,911) 2,360
Cash and cash equivalents at beginning of period 7,037 4,815
-------- --------
Cash and cash equivalents at end of period $ 5,126 $ 7,175
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the period for:
Income taxes $ 252 $ 544
Interest $ 2,545 $ 2,929
The accompanying Notes to Consolidated Financial Statements are an integral part
of these statements.
5
CORRPRO COMPANIES, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE 1 - INTERIM FINANCIAL STATEMENTS
The accompanying interim consolidated financial statements include the
accounts of Corrpro Companies, Inc. and subsidiaries (the "Company"). All
significant intercompany accounts and transactions have been eliminated in
consolidation.
The information furnished in the accompanying interim consolidated
financial statements has not been audited by independent accountants. In the
opinion of management, the interim consolidated financial statements include all
adjustments, consisting only of normal and recurring adjustments, necessary for
a fair presentation of the consolidated financial position, results of
operations and cash flows for the interim periods presented. The results of
operations for the three months or for the six months ended September 30, 2003
are not necessarily indicative of the results that may be expected for the
fiscal year ending March 31, 2004 or any other period. The interim consolidated
financial statements should be read in conjunction with the Company's Annual
Report on Form 10-K for the fiscal year ended March 31, 2003.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results
could differ from those estimates.
NOTE 2 - INVENTORIES
September 30, March 31,
2003 2003
------ ------
Inventories consist of the following:
Component parts and raw material $4,959 $5,250
Finished goods 4,258 2,983
------ ------
$9,217 $8,233
====== ======
NOTE 3 - PROPERTY, PLANT AND EQUIPMENT
September 30, March 31,
2003 2003
------------- ---------
Property, plant and equipment consist of the following:
Land $ 532 $ 443
Buildings and improvements 5,987 4,897
Equipment, furniture and fixtures 16,187 15,610
-------- --------
22,706 20,950
Less: Accumulated depreciation (15,853) (13,968)
-------- --------
$ 6,853 $ 6,982
======== ========
NOTE 4 - EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing net income
for the period by the
6
weighted average number of common shares outstanding for the period, which was
8,408 and 8,403 for the three months ended September 30, 2003 and 2002,
respectively, and 8,408 and 8,376 for the six months ended September 30, 2003
and 2002, respectively. Diluted EPS for the period has been determined by
dividing net income by the weighted average number of common shares and
potential common shares outstanding for the period, which was 9,356 and 8,403
for the three months ended September 30, 2003 and 2002, respectively and 9,382
and 8,376 for the six months ended September 30, 2003 and 2002, respectively.
Stock options and the warrants are the only potential common shares.
NOTE 5 - STOCK PLANS
The Company granted options to purchase 10 and 36 common shares under
the 1997 Option Plan and the Non-Employee Director Option Plan during the six
months ended September 30, 2003 and 2002, respectively. In addition, options
previously granted to purchase 120 and 49 common shares at exercise prices
ranging from $1.30 to $12.10 expired or were forfeited during the six months
ended September 30, 2003 and 2002, respectively.
Stock-based compensation
As permitted by Statement of Financial Accounting Standard (SFAS), No.
123, "Accounting for Stock-Based Compensation," (SFAS 123), the Company accounts
for employee stock-based compensation in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and
the Financial Accounting Standards Board (FASB) Interpretation No. 44,
"Accounting for Certain Transactions Involving Stock-Based Compensation, an
interpretation of APB Opinion No. 25" (FIN 44) and related interpretations.
Stock-based compensation related to non-employees is based on the fair value of
the related stock or options in accordance with SFAS 123 and its
interpretations. Expense associated with stock-based compensation is amortized
over the vesting period of each individual award. The following table
illustrates the effect on net income (loss) and income (loss) per common share
as if the Black-Scholes fair value method described in SFAS 123 had been applied
to the Company's stock option plans:
FOR THE THREE FOR THE SIX
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net loss:
As reported $ (1,880) $ (3,358) $ (1,047) $ (24,043)
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all awards 96 80 246 203
---------- ---------- ---------- ----------
Pro forma loss $ (1,976) $ (3,438) $ (1,293) $ (24,246)
========== ========== ========== ==========
Basic loss per share:
As reported $ (0.22) $ (0.40) $ (0.12) $ (2.87)
Pro Forma $ (0.24) $ (0.41) $ (0.15) $ (2.89)
Diluted loss per share:
As reported $ (0.20) $ (0.40) $ (0.11) $ (2.87)
Pro Forma $ (0.21) $ (0.41) $ (0.14) $ (2.89)
For purposes of this pro forma, the fair value of each option grant was
estimated using the Black-Scholes option-pricing model. The significant
assumptions used were a risk-free interest rate of 3.3%, an expected volatility
of 164.0%, an expected life of 10 years and no expected dividends.
7
NOTE 6 - SHAREHOLDERS' EQUITY
During the quarter ended September 30, 2002, the Company issued
warrants to the lenders (see Note 12 - Revolving Credit Facility and Senior
Notes) under its Revolving Credit Facility and Senior Notes. The warrant issued
to the Revolving Credit Facility lender permits the lender to purchase 467
shares at a purchase price of $0.01 per share, and the warrant issued to the
Senior Notes lender permits the lender to purchase up to 467 shares at a
purchase price of $0.01 per share. For purposes of financial reporting, the
warrants were valued at $313 each and the aggregate amount of $626 increased
paid-in-capital and reduced short-term and long-term debt. The $313 discount
per facility was fully amortized by the Revolving Credit Facility termination
date of July 2003, and will be fully amortized by the Senior Notes termination
date of January 15, 2008.
NOTE 7 - COMPREHENSIVE INCOME
Accumulated other comprehensive income (loss) is reported separately
from retained earnings and additional paid-in-capital in the Consolidated
Balance Sheets. Items considered to be other comprehensive income (loss)
includes adjustments made for foreign currency translation (under SFAS No. 52)
and pensions (under SFAS No. 87).
Components of other accumulated comprehensive loss consist of foreign
currency translation adjustments of $(679) and $(1,597) as of September 30, 2003
and March 31, 2003, respectively.
Components of comprehensive income (loss) consist of the following:
Six Months Ended September 30,
2003 2002
-------- --------
Net income (loss) $ (1,047) $(24,043)
Other Comprehensive income (loss):
Write-off of translation adjustment
related to discontinued operations
-- 3,546
Write-off of translation adjustment
related to European operations -- (247)
Write-off of Pension -- 498
Translation adjustment 918 (576)
-------- --------
Total comprehensive income (loss) $ (129) $(20,822)
======== ========
NOTE 8 - ASSETS AND LIABILITIES HELD FOR SALE
In July 2002, the Company's Board of Directors approved a formal
business restructuring plan. The multi-year plan includes a series of
initiatives to improve operating income and reduce debt. The Company intends to
sell non-core business units and use the proceeds to reduce debt. The Company
has engaged outside professionals to assist in the disposition of the domestic
and international non-core business units. Prior to the quarter ended September
30, 2002, the Company's non-core domestic and international units were reported
as the Other Operations and International Operations reporting segments.
Effective for the quarter ended September 30, 2002, the Other Operations and the
International Operations reporting segments have been eliminated and the
non-core domestic and
8
international units are reported as discontinued operations. Prior-year
financial statements have been reclassified to reflect these non-core units as
discontinued operations, which are also referred to as "assets and liabilities
held for sale."
In the second quarter of fiscal 2004, the Company's Board of Directors
had approved a resolution to keep the European Operations and remove them from
discontinued operations. Effective in the second quarter of fiscal 2004, the
Company reported quarterly and annual results of the European Operations in its
continuing operations. Prior-year financial statements have been reclassified to
reflect the European Operations as continuing operations.
Assets and liabilities held for sale as of September 30, 2003 and March
31, 2003 consisted of:
September 30, March 31,
2003 2003
------------- ---------
Cash $ 1,009 $ 1,296
Accounts receivable 3,625 4,656
Inventory 1,189 1,394
Prepaid expenses 1,843 2,173
Property, plant and equipment, net (263) (101)
Goodwill and other assets 148 428
------ -------
Assets held for sale $ 7,551 $ 9,846
====== =======
Current liabilities $ 4,945 $ 3,525
Deferred taxes -- (71)
------ -------
Liabilities held for sale $4,945 $ 3,454
====== =======
The Company allocated interest to discontinued operations of $66 and
$411 for the three months ended September 30, 2003 and 2002, respectively, and
$255 and $813 for the six months ended September 30, 2003 and 2002,
respectively, based on estimated proceeds from the discontinued operations
disposition that will be used to pay down the Revolving Credit Facility and
Senior Notes (see Note 12 - Revolving Credit Facility and Senior Notes). The
interest rate used to calculate the interest expense allocated was the weighted
average interest rate of the Revolving Credit Facility and Senior Notes.
Potential operating gains or losses may be experienced with the
disposition of the non-core assets at the time of disposal during implementation
of the restructuring plan. Listed below are the statements of operations for
discontinued operations for the three months ended September 30, 2003 and 2002
and six months ended September 30, 2003 and 2002.
<Table>
<Caption>
For the Three For the Six
Months Ended Months Ended
September 30, September 30,
------------------------ -----------------------
2003 2002 2003 2002
-------- -------- -------- --------
Revenues $ 2,610 $ 7,592 $ 6,076 $ 13,833
Operating cost and expenses:
Cost of sales 2,003 5,028 4,687 9,111
Selling, general & administrative expenses 3,764 4,903 4,738 7,951
-------- -------- -------- --------
Operating income (loss) (3,157) (2,339) (3,349) (3,229)
9
Loss on disposal -- -- 46 --
Interest expense 66 411 255 813
-------- -------- -------- --------
Income (loss) from discontinued operations
before income taxes (3,223) (2,750) (3,650) (4,042)
Provision for income taxes -- 78 -- 78
-------- -------- -------- --------
Income (loss) from discontinued operations $ (3,223) $ (2,828) $ (3,650) $ (4,120)
======== ======== ======== ========
During the second quarter of fiscal 2004, the Company recorded an
impairment charge relating to its Middle East Operations of $3,278. During the
first quarter of fiscal 2004, the Company sold its Asia Pacific Operations for a
net loss of $46 after taking into account an impairment charge on net assets
which was recorded during the fourth quarter of fiscal 2003 totaling $1,575.
During fiscal 2003, the Company disposed of four non-strategic business units.
First, in March 2003, the Company sold its Bass Trigon Software business unit
for $3,150 and recognized a gain of $194. Also, in March 2003, the Company
recorded a note receivable for $6,232, for which the Company collected $5,932 on
April 2, 2003, for its Rohrback Cosasco Systems subsidiary and recognized a gain
of $1,809. The Company also disposed of two smaller international offices with a
net gain of $92 during fiscal 2003. The net proceeds from dispositions were used
to pay down debt.
NOTE 9 - RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 46, "Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51." This Interpretation addresses the consolidation
by business enterprises of various interest entities as defined in the
Interpretation. The Company does not expect the adoption of this Interpretation
to have a material impact on its results of operations or financial position.
In April 2003, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities." This statement amends SFAS No. 133 for
decisions made (1) as part of the Derivatives Implementation Group process that
effectively required amendments to SFAS No. 133, (2) in connection with other
FASB projects dealing with financial instruments and (3) in connection with
implementation issues raised in relation to the application of the definition of
a derivative. This statement is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003, with certain exceptions. The Company has adopted SFAS No. 149 and the
adoption has not had a material impact on its results of operations or financial
position.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments and Characteristics of both Liabilities and Equity" which
requires freestanding financial instruments such as mandatorily redeemable
shares, forward purchase contracts and written put options to be reported as
liabilities by their issuers as well as related new disclosure requirements. The
provisions of SFAS No. 150 are effective for instruments entered into or
modified after May 31, 2003 and pre-existing instruments as of the beginning of
the first interim period that commences after June 15, 2003. The application of
this statement has not had an effect on the Company's consolidated financial
statements.
NOTE 10 - PRODUCT WARRANTIES
10
In the normal course of business, we provide warranties and
indemnifications for our products and services. We provide warranties that the
products we distribute are in compliance with prescribed specifications. In
addition, we have indemnity obligations to our customers for these products,
which have also been provided to us from our suppliers, either through express
agreement or by operation of law.
At September 30, 2003, accrued warranty costs were not material to the
consolidated balance sheet.
NOTE 11 - BUSINESS SEGMENTS
In July 2002, the Company's Board of Directors approved a formal
business restructuring plan. The multi-year plan includes a series of
initiatives to improve operating income and reduce debt. The Company intends to
sell non-core business units and use the proceeds to reduce debt. The Company
has engaged outside professionals to assist in the disposition of the domestic
and international non-core business units. Prior to the quarter ended September
30, 2002, the Company's non-core domestic and international units were reported
as the Other Operations and International Operations reporting segments.
Effective as of the quarter ended September 30, 2002, the Other Operations and
the International Operations reporting segments have been eliminated and the
non-core domestic and international units are reported as discontinued
operations. Prior-year financial statements have been reclassified to reflect
these non-core units as discontinued operations, which are also referred to as
"assets and liabilities held for sale."
In the second quarter of fiscal 2004, the Company's Board of Directors
had approved a resolution to keep the European Operations and remove them from
discontinued operations. Effective in the second quarter of fiscal 2004, the
Company reported quarterly and annual results of the European Operations in its
continuing operations. Prior-year financial statements have been reclassified to
reflect the European Operations as continuing operations.
We have organized our operations into three business segments: Domestic
Core Operations, Canadian Operations and European Operations. Our business
segments and a description of the products and services they provide are
described below:
Domestic Core Operations. The Domestic Core Operations segment consists
of the Company's operations in the United States, which provide products and
services including corrosion control, coatings, pipeline integrity, risk
assessment and inspection services. This segment provides corrosion control
products and services to a wide-range of customers in a number of industries
including: energy, utilities, water and wastewater treatment, chemical and
petrochemical, pipelines, defense and municipalities. In addition, this segment
provides coatings services to customers in the entertainment, aerospace,
transportation, petrochemical and electric power industries, as well as
inspection services to customers in the pharmaceutical, chemical and energy
industries. Finally, this segment includes a production facility in the United
States that assembles and distributes cathodic protection products, such as
anodes, primarily to the United States market.
Canadian Operations. The Canadian Operations segment provides corrosion
control, pipeline integrity and inspection services to customers in Canada who
are primarily in the oil and gas industry. These customers include pipeline
operators, petrochemical plants and refineries. The Canadian Operations segment
also includes production facilities that assemble products such as anodes and
rectifiers.
11
European Operations. The European Operations segment provides corrosion
control products and services to customers in the petroleum, utility,
industrial, marine and offshore markets, as well as to governmental entities in
connection with their infrastructure assets.
Financial information relating to the Company's operations by segment
are presented below:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
-------- -------- -------- --------
Revenue:
Domestic Core Operations $ 24,820 $ 23,105 $ 48,798 $ 45,560
Canadian Operations 6,522 5,180 12,219 9,561
European Operations 3,091 3,188 6,468 6,041
-------- -------- -------- --------
$ 34,433 $ 31,473 $ 67,485 $ 61,162
======== ======== ======== ========
Operating Income:
Domestic Core Operations $ 4,108 $ 3,553 $ 8,529 $ 6,876
Canadian Operations 1,840 1,500 2,814 2,243
European Operations 382 (563) 735 (303)
Corporate Related Costs and Other (2,723) (3,071) (5,379) (6,898)
-------- -------- -------- --------
$ 3,607 $ 1,419 $ 6,699 $ 1,918
======== ======== ======== ========
NOTE 12 - REVOLVING CREDIT FACILITY AND SENIOR NOTES
Revolving Credit Facility. In March 1999, the Company entered into an
$80 million revolving credit facility that originally expired on April 30, 2002
(the "Revolving Credit Facility"). Initial borrowings were used to repay
existing domestic bank indebtedness. Through a series of subsequent amendments,
including an amendment executed by the Company on November 14, 2003 and
effective as of October 31, 2003, ("November 2003 Revolver Amendment"), the size
of the Revolving Credit Facility was reduced to $27.5 million and the expiration
date was extended to January 31, 2004. Borrowings under the Revolving Credit
Facility are further limited to borrowing base amounts as defined. The Revolving
Credit Facility provides for interest on borrowings at prime plus 5.00% and
requires the Company to pay a facility fee of 1.00% on the commitment amount.
The rate at September 30, 2003 was 9.0%.
Borrowings under the Revolving Credit Facility, as amended, are secured
by the Company's domestic accounts receivable, inventories, certain intangibles,
machinery and equipment and owned real estate as well as certain assets in
Canada. The Company also has pledged slightly less than two-thirds of the
capital stock of two of its foreign subsidiaries. The Revolving Credit Facility,
as amended, requires the Company to maintain certain financial ratios and places
limitations on the Company's ability to pay cash dividends, incur additional
indebtedness and make investments, including acquisitions. At September 30,
2003, the Company had $21,887 outstanding under the Revolving Credit Facility.
Total availability under the Revolving Credit Facility at September 30, 2003 was
approximately $1,298, after giving consideration to the borrowing base
limitations, under the Revolving Credit Facility. At September 30, 2003, the
Company was in compliance with the financial covenants under the Revolving
Credit Facility, as amended by the November 2003 Revolver Amendment.
Under the terms of the amendments to the Revolving Credit Facility, any
cash proceeds from
12
the disposition of targeted Company assets will be used to reduce the Revolving
Credit Facility and the Senior Notes in a ratio of 56% and 44%, respectively.
Any net asset disposition payments to reduce the Revolving Credit Facility will
result in a proportionate reduction in the lender's commitments in the Revolving
Credit Facility.
In connection with the Sixth Amendment to the Revolving Credit
Facility, the lender group received a warrant ("Revolving Credit Facility
Warrant") to purchase 467 of the Company's common shares at a purchase price of
$0.01 per share exercisable at any time after July 31, 2003 until September 23,
2012. The Revolving Credit Facility Warrant contains a provision which permitted
the Company to reduce the amount of the Revolving Credit Facility Warrant by up
to 50% based upon prepayments of principal made by the Company under the
Revolving Credit Facility prior to July 31, 2003 with cash proceeds received
from the disposition of targeted Company assets. These prepayments resulted in
the Revolving Credit Facility Warrant being reduced by approximately 82 common
shares at July 31, 2003.
Senior Notes. In January 1998, the Company issued, through a private
placement, $30 million of Senior Notes due 2008 (the "Senior Notes"). Through a
series of subsequent amendments, including an amendment executed by the Company
on November 14, 2003 and effective as of October 31, 2003 (the "November 2003
Senior Notes Amendment"), the terms and conditions of the Senior Notes have been
modified to, among other things, change the interest rate payable on the Senior
Notes and to defer certain principal payments thereunder. The Senior Notes, as
amended, bear interest at 11.35% until January 31, 2004. In addition, the
agreement relating to the Senior Notes (the "Senior Notes Agreement"), as
amended, provides for any overdue amount to bear an interest rate of the greater
of 13.35% or 2.00% over the rate of interest publicly announced by The Bank of
New York from time to time in New York City as its Prime Rate on the outstanding
principal payments and overdue amounts.
The Senior Notes require a principal payment of $8,712, which has been
deferred pursuant to the November 2003 Senior Notes Amendment to January 31,
2004, and monthly principal payments of $384, the commencement of which has been
similarly deferred until February 15, 2004 ("Notes Principal Repayments") and
are secured equally and ratably with debt under the Revolving Credit Facility.
In addition, the Senior Notes Agreement, as amended, provides that any cash
proceeds from the disposition of targeted Company assets will be used to reduce
the Revolving Credit Facility and the Senior Notes in a ratio of 56% and 44%,
respectively. The Company is required to maintain certain financial ratios under
the Senior Notes Agreement. As of September 30, 2003, the Company is currently
in compliance with the financial covenants under the amended Senior Notes
Agreement.
Within the Senior Notes Agreement is a yield maintenance amount
provision, which ensures that the lender is paid the entire interest amount of
the Senior Notes. The yield maintenance amount provisions apply to certain
optional prepayments of principal under the Senior Notes and provides that the
Senior Notes shall be subject to prepayment, in whole at any time or from time
to time in part, at the option of the Company, at 100% of the principal amount
so prepaid plus interest thereon to the prepayment date and the yield
maintenance amount, if any, with respect to each Senior Note. Any partial
prepayment of the Senior Notes, which meet certain criteria, shall be applied
against the principal amount of the Senior Notes scheduled to become due in the
inverse order of maturity thereof. Fiscal year 2003 results include an interest
charge of approximately $1,045 relating to the yield maintenance amount
provisions of the Senior Notes Agreement.
In connection with prior amendments in September 2002, the Senior Notes
lender received a warrant ("Senior Notes Warrant") to purchase 467 of the
Company's Common Shares at a purchase price of $0.01 per share exercisable at
any time after July 31, 2003 until September 23, 2012. The
13
Senior Notes Warrant contains a provision which permitted the Company to reduce
the amount of the Senior Notes Warrant by up to 50% based upon prepayments of
principal made by the Company under the Senior Notes prior to July 31, 2003 with
cash proceeds received from the disposition of targeted Company assets. These
prepayments resulted in the Senior Notes Warrant being reduced by approximately
82 common shares at July 31, 2003.
The Proposed Transaction. As previously publicly reported, the Company
has entered into a non-binding letter of intent with an undisclosed investment
firm with respect to the recapitalization and refinancing of the Company (the
"Proposed Transaction"). The Proposed Transaction is subject to a number of
conditions, including that the parties secure commitments for senior and
subordinated debt financing and that the parties enter into definitive
agreements. In addition, the proposed transaction would require approval from
the Company's shareholders as well as from the lenders under both the Revolving
Credit Facility and the Senior Notes. Each of the November 2003 Revolver
Amendment and the November 2003 Senior Notes Amendment requires the Company to
meet certain milestones related to its efforts to consummate the Proposed
Transaction, which the Company has satisfied to date. There can be no assurance
that the Proposed Transaction will be consummated, and if consummated, what the
terms for such transaction will be.
If the Company cannot successfully consummate the Proposed Transaction
on or before January 31, 2004, it will need to negotiate arrangements with its
lenders to, among other things, extend the maturity of the Revolving Credit
Facility and defer the Notes Principal Repayments beyond January 31, 2004. There
can be no assurance, however, that the Company will be able to reach acceptable
arrangements with its existing lenders or on what terms such arrangements would
be. If the Company is not able to negotiate mutually acceptable arrangements
with its existing lenders, events could occur that would have a material adverse
effect on the Company's liquidity and financial condition and could result in
its inability to operate as a going concern. If the Company is unable to operate
as a going concern, it may file, or have no alternative but to file, bankruptcy
or insolvency proceedings or pursue a sale or sales of assets to satisfy
creditors.
NOTE 13 - CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE
In June 2001, Statement of Financial Accounting Standards No. 141,
"Business Combinations" ("SFAS 141"), and Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), were
issued by the Financial Accounting Standards Board. SFAS 141 eliminates the
pooling-of-interests method for business combinations and requires the use of
the purchase method and establishes criteria to be used in determining whether
acquired intangible assets are to be separated from goodwill.
In July 2001, Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"), were issued by the
Financial Accounting Standards Board. SFAS 142 changes the accounting for
goodwill and indefinite life intangibles from an amortization approach to a
non-amortization approach, and require periodic tests for impairment of these
assets. Upon the Company's adoption of SFAS 142 on April 1, 2002, the provisions
of SFAS 142 required the discontinuance of amortization of goodwill and
indefinite life intangibles that had been recorded in connection with previous
business combinations. The Company has completed its initial impairment testing
as of April 1, 2002 under SFAS 142 and recorded an impairment loss totaling
$18,238 of which $11,832 related to discontinued operations and $6,406 related
to continuing operations. The loss was recognized as the cumulative effect of a
change in accounting principle. This impairment testing is also
14
done annually in the fourth quarter and such testing indicated no additional
impairment as of March 31, 2003.
Amortizable intangibles at September 30, 2003 amounted to a net book
value of $994. These intangibles are primarily related to patents and trademarks
with useful lives ranging from 3 to 15 years. Amortization expense for each of
the next five years is expected to be $242.
NOTE 14 - SUBSEQUENT EVENT
During the second quarter of fiscal 2004, the Company recorded an
impairment charge relating to its Middle East Operations. Subsequent to the
second quarter of fiscal 2004, the Company has signed a purchase agreement with
an undisclosed buyer of its Middle East Operations. The transaction is
anticipated to close prior to the fiscal 2004 year-end but is subject to local
government approval and other closing conditions. There can be no assurance that
this transaction will be completed.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
- ------- RESULTS OF OPERATIONS
GENERAL
- -------
Corrpro Companies, Inc. was founded in 1984 and is organized under the
laws of the State of Ohio. As used in this report, the terms "Corrpro" and the
"Company" mean Corrpro Companies, Inc. and its consolidated subsidiaries unless
the context indicates otherwise.
PRODUCTS AND SERVICES
Corrpro provides corrosion control related services, systems, equipment
and materials to the infrastructure, environmental and energy markets. Our
products and services include (i) corrosion control engineering services,
systems and equipment ("corrosion control"), (ii) coatings services ("coatings")
and (iii) pipeline integrity and risk assessment services.
CORROSION CONTROL. Corrpro's specialty in the corrosion control market
is cathodic protection. We offer a comprehensive range of services in this area,
which include the design, manufacture, installation, maintenance and monitoring
of cathodic protection systems. Cathodic protection is an electrochemical
process that prevents corrosion for new structures and stops the corrosion
process for existing structures. It can provide a cost-effective alternative to
the replacement of corroding structures. In order to understand how cathodic
protection works, it is helpful to first understand the corrosion process.
Steel, the most common metal protected by cathodic protection, is produced from
iron ore. To produce steel, the iron ore is subjected to a refining process that
adds energy. Once the steel is put back into the environment, it begins to
revert back to its original state (i.e., iron ore) by releasing the added energy
back into the surrounding environment. This process of dispersing energy is
called corrosion. Cathodic protection electrodes, called anodes, are placed
near, and connected to, the structure to be protected (i.e., the cathode).
Anodes are typically made from cast iron, graphite, aluminum, zinc or magnesium.
A cathodic protection system works by passing an electrical current from the
anode to the cathode. This process maintains the energy level on the cathode,
thus stopping it from corroding. Instead, the anode corrodes, sacrificing itself
to maintain the integrity of the structure. In order for the electrical current
to pass from the anode to the cathode, they both must be in a common
environment. Therefore, cathodic protection can only be used to protect
structures that are buried in soil, submerged in water or encased in concrete.
Structures commonly protected against corrosion by the cathodic protection
process include oil and gas pipelines, offshore platforms, above and underground
storage tanks, ships, electric power plants, bridges, parking garages, transit
systems and water and wastewater treatment equipment.
In addition to cathodic protection, our corrosion control services
include corrosion engineering, material selection, inspection services, advanced
corrosion research and testing. We also sell a variety of materials and
equipment including anodes, rectifiers and corrosion monitoring probes used in
cathodic protection and corrosion monitoring systems.
COATINGS. Corrpro offers a wide variety of coatings-related services
designed to provide our customers with longer coatings life, reduced corrosion,
improved aesthetics and lower life-cycle costs for their coated structures.
Coatings services include research, testing, evaluation and application of
coatings. In addition, we provide project management services for coatings
maintenance programs, including condition surveys, failure analysis, selection
of site surface preparation methods and selection and application of coatings.
We also provide specialized coatings application services for structures
16
with aggressive corrosion conditions such as the inside and outside of storage
tanks and pipelines.
PIPELINE INTEGRITY AND RISK ASSESSMENT SERVICES. Corrpro offers a
comprehensive line of pipeline integrity, risk assessment and inspection
services, including assessment, surveys, inspection, analysis, repairs and
ongoing maintenance. By offering a wide range of services, we are able to
provide pipeline owners with one-stop shopping for the preservation of their
pipeline systems.
DISPOSITIONS
In July 2002, the Company's Board of Directors approved a formal
business restructuring plan. The multi-year plan includes a series of
initiatives to improve operating income and reduce debt. The Company intends to
sell non-core business units and use the proceeds to reduce debt. The Company
has engaged outside professionals to assist in the disposition of the domestic
and international non-core business units. Prior to the quarter ended September
30, 2002, the Company's non-core domestic and international units were reported
as the Other Operations and International Operations reporting segments.
Effective as of the quarter ended September 30, 2002, the Other Operations and
the International Operations reporting segments have been eliminated and the
non-core domestic and international units are reported as discontinued
operations. Prior-year financial statements have been reclassified to reflect
these non-core units as discontinued operations, which are also referred to as
"assets and liabilities held for sale."
In the second quarter of fiscal 2004, the Company's Board of Directors
had approved a resolution to keep the European Operations and remove them from
discontinued operations. Effective in the second quarter of fiscal 2004, the
Company reported quarterly and annual results of the European Operations in its
continuing operations. Prior-year financial statements have been reclassified to
reflect the European Operations as continuing operations.
During fiscal 2004, the Company sold its Asia Pacific Operations for a
minimal loss after taking into account an impairment charge on net assets which
was recorded during the fourth quarter of fiscal 2003 totaling $1.6 million.
During fiscal 2003, four non-strategic business units were sold. These
dispositions included Rohrback Cosasco Systems subsidiary, Bass Trigon Software
business unit and two smaller international offices. The proceeds from these
dispositions were used to pay down debt. For further information about our
discontinued operations see Note 8, Assets and Liabilities Held for Sale, Notes
to Consolidated Financial Statements.
SEGMENTS
We have organized our operations into three business segments: Domestic
Core Operations, Canadian Operations and European Operations. Our non-core
domestic, which were sold in fiscal 2003, our Asia Pacific, which was sold in
the first quarter of fiscal 2004, and our Middle East Operations are reported as
discontinued operations. Our business segments and a description of the products
and services they provide are described below:
DOMESTIC CORE OPERATIONS. The Domestic Core Operations segment consists
of the Company's operations in the United States, which provide products and
services including corrosion control, coatings, pipeline integrity, risk
assessment and inspection services. This segment provides corrosion control
products and services to a wide-range of customers in a number of industries
including: energy, utilities, water and wastewater treatment, chemical and
petrochemical, pipelines, defense and municipalities. In addition, this segment
provides coatings services to customers in the entertainment,
17
aerospace, transportation, petrochemical and electric power industries, as well
as inspection services to customers in the pharmaceutical, chemical and energy
industries. Finally, this segment includes a production facility in the United
States that assembles and distributes cathodic protection products, such as
anodes, primarily to the United States market.
CANADIAN OPERATIONS. Our Canadian Operations segment provides corrosion
control, pipeline integrity and inspection services to customers in Canada,
which are primarily in the oil and gas industry. These customers include
pipeline operators and petrochemical plants and refineries. The Canadian
Operations segment also includes production facilities that assemble products
such as anodes and rectifiers.
EUROPEAN OPERATIONS. The European Operations segment provides corrosion
control products and services to customers in the petroleum, utility,
industrial, marine and offshore markets, as well as to governmental entities in
connection with their infrastructure assets.
A. RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED
TO THREE MONTHS ENDED SEPTEMBER 30, 2002
REVENUES
- --------
Revenues from continuing operations for the fiscal 2004 second quarter
totaled $34.4 million compared to $31.5 million in the fiscal 2003 second
quarter, an increase of $2.9 million, or 9.4%. Revenues from the discontinued
operations were $2.6 million in the fiscal 2004 second quarter compared to $7.6
million in the prior-year period. The decrease in discontinued operations is
primarily attributable to the sale of several discontinued businesses.
Fiscal 2004 second quarter revenues relating to our Domestic Core
Operations segment totaled $24.8 million compared to $23.1 million in the fiscal
2003 second quarter, an increase of $1.7 million or 7.4%. This revenue increase
relates primarily to a large engineering project that started in late calendar
2002 and is scheduled to continue into fiscal year 2005. Also, contributing to
this increase were improved revenue levels in our coatings services and material
sales businesses compared to the prior-year period.
Our Canadian Operations segment revenues for the second quarter of
fiscal 2004 totaled $6.5 million compared to $5.2 million in the prior-year
second quarter, an increase of $1.3 million or 25.9%. This increase is due
primarily to increased volume of material and rectifier sales as well as
increases in the energy segment of our business.
Our European Operations segment revenues for the second quarter of
fiscal 2004 totaled $3.1 million compared to $3.2 million in the prior-year
second quarter, a decrease of $0.1 million or 3.1%. Revenues remained relatively
flat quarter-over-quarter.
GROSS PROFIT
- ------------
Gross profit margins were 33.4% for the fiscal 2004 second quarter
compared to 33.5% for the fiscal 2003 second quarter. Gross margins continue to
benefit from a number of high margin jobs offset by lower margin material sales
in our Domestic Core Operations and Canadian Operations, as well as our overall
continued effort to improve operating efficiencies and productivity.
18
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
- --------------------------------------------
Selling, general and administrative expenses totaled $7.9 million
(22.9% of revenues) for the fiscal 2004 second quarter compared to $9.1 million
(29.0% of revenues) in the fiscal 2003 second quarter, a decrease of $1.2
million. The fiscal 2004 second quarter had $0.6 million related to professional
fees associated with our lender requirements while the fiscal 2003 second
quarter had $0.7 million in professional fees related to lender requirements,
$0.7 million of pension expense related to our European Operations and a $0.5
million impairment charge recorded for our European Operations. Selling, general
and administrative expenses, as a percentage of revenue, continue to show
positive results from our efforts to streamline our operations.
OPERATING INCOME FROM CONTINUING OPERATIONS
- -------------------------------------------
Operating income totaled $3.6 million in the second quarter of fiscal
2004 compared to $1.4 million for the fiscal 2003 second quarter, an increase of
$2.2 million. The increase in operating income in the fiscal 2004 second quarter
resulted from improved revenue levels and lower operating expenses.
INTEREST EXPENSE
- ----------------
Interest expense totaled $1.6 million in the second quarter of fiscal
2004 compared to $1.5 million in the fiscal 2003 second quarter, an increase of
$0.1 million. Interest rates increased as a result of amending our credit
facilities, which were partially offset by lower debt levels.
INCOME TAX PROVISION
- --------------------
The Company recorded a provision for income taxes of $0.7 million for
the fiscal 2004 second quarter compared to a provision of $0.4 million for the
fiscal 2003 second quarter. Our income tax provision is based on our effective
tax rate. Our effective tax rate is based on the statutory rates in effect in
the countries in which we operate. The Company recorded a provision below the
statutory tax rate of 34% since the Company has utilized the tax benefits of
losses in the Domestic Core Operations for which a previously recorded valuation
allowance has been provided for. The Company intends to maintain a full
valuation allowance on its domestic net deferred tax assets and net operating
loss carry-forwards until sufficient evidence exists to support the reversal of
the remaining reserve.
INCOME (LOSS) FROM CONTINUING OPERATIONS
- ----------------------------------------
Income from continuing operations for the fiscal 2004 second quarter
was $1.3 million compared to a loss of $0.5 million in the second quarter of
fiscal 2003, an increase of $1.8 million. The fiscal 2004 second quarter
increase in operating income is the result of improved revenue levels improved
operating efficiencies and our overall efforts to streamline operations.
DISCONTINUED OPERATIONS
- -----------------------
Loss from discontinued operations for the fiscal 2004 second quarter
was $3.2 million compared to a loss from discontinued operations of $2.8 million
in the prior-year period, an increase of $0.4 million. Also, during the second
quarter of fiscal 2004, the Company recorded a $3.3 million impairment charge on
net assets related to its Middle East Operations, which is included in
discontinued operations.
19
NET LOSS
- --------
Net loss totaled $1.9 million in the second quarter of fiscal 2004
compared to a net loss of $3.4 million in the prior-year period, an increase in
earnings of $1.5 million. Loss per share on a diluted basis totaled $0.20 per
share compared to $0.40 in the year-earlier period.
RESULTS OF OPERATIONS - SIX MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO
SIX MONTHS ENDED SEPTEMBER 30, 2002
REVENUES
- --------
Revenues from continuing operations for the six months ended September
30, 2003 totaled $67.5 million compared to prior-year revenues of $61.2 million,
an increase of $6.3 million or 10.3%. Revenues from the discontinued operations
were $6.1 million for the first six months of fiscal 2004 compared to $13.8
million in the prior-year period, a decrease of $7.8 million. The decrease in
discontinued operations is primarily attributable to the sale of several
discontinued businesses.
For the six months ended September 30, 2003, revenues relating to the
Domestic Core Operations totaled $48.8 million compared to prior-year results of
$45.6 million, an increase of $3.2 million or 7.1%. This revenue increase
relates primarily to a large engineering project that started in late calendar
2002 and is scheduled to continue into fiscal year 2005. Also contributing to
this increase were improved revenue levels in our coatings services and material
sales businesses compared to the prior-year period.
The Canadian Operations' revenues for the six months ended September
30, 2003 totaled $12.2 million compared to prior-year results of $9.6 million,
an increase of $2.7 million or 27.8%. The increase is primarily due to increased
material and rectifier sales. The increase is due primarily to increased volume
of material and rectifier sales as well as increases in the energy segment of
our business.
The European Operations' revenues for the six months ended September
30, 2003 totaled $6.5 million compared to prior-year results of $6.0 million, an
increase of $0.5 million or 7.1%. The increase is primarily due to improved
volume levels of material sale year-over-year.
GROSS PROFIT
- ------------
Consolidated gross profit margins were 33.4% for the six months ended
September 30, 2003 compared to 32.8% for the prior-year period. Gross margins
continue to benefit from a number of high margin jobs in both the Domestic Core
Operations and the Canadian Operations.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
- --------------------------------------------
Selling, general and administrative expenses totaled $15.9 million
(23.5% of revenues) for the six months ended September 30, 2003 compared to
$18.2 million (29.7% of revenues) for the prior-year period. Selling, general
and administrative expenses for the six months ended September 30, 2003 had $1.0
million related to professional fees associated with our lender requirements
while the prior-year period had $1.6 million in professional fees related to
lender requirements, $0.7 million related to pension expense related to our
European Operations and a $0.5 million impairment charge recorded for our
European Operations. Selling, general and administrative expenses, as a
percentage of revenue,
20
continue to show positive results from our efforts to streamline our operations.
OPERATING INCOME FROM CONTINUING OPERATIONS
- -------------------------------------------
Operating income from continuing operations totaled $6.7 million for
the six months ended September 30, 2003 compared to $1.9 million in the
prior-year period, an increase in earnings of $4.8 million. This increase is
primarily related to the prior-years restructuring costs incurred and improved
revenues generated during the current fiscal year.
INTEREST EXPENSE
- ----------------
Interest expense totaled $3.1 million for the six months ended
September 30, 2003 compared to $2.8 million in the prior-year period. Interest
rates increased as a result of amending our credit facilities, which were
partially offset by the lower debt levels.
INCOME TAX PROVISION
- --------------------
The Company recorded a provision for income taxes of $1.0 million for
the six months ended September 30, 2003 compared to a provision of $0.8 million
in the prior-year period. Our income tax provision is based on our effective tax
rate. Our effective tax rate is based on the statutory rates in effect in the
countries in which we operate. The Company recorded a provision below the
statutory tax rate of 34% since the Company has not realized the tax benefits of
losses in the domestic operations for which a previously recorded valuation
allowance has been provided for. The Company intends to maintain a full
valuation allowance on its domestic net deferred tax assets and net operating
loss carryforwards until sufficient evidence exists to support the reversal of
the remaining reserve.
INCOME (LOSS) FROM CONTINUING OPERATIONS
- ----------------------------------------
The income from continuing operations totaled $2.6 million for the six
months ended September 30, 2003 compared to a loss of $1.7 million of income
from continuing operations in the prior-year period, an increase in earnings of
$4.3 million. The fiscal 2004 six months operating income is the result of
improved revenue levels, improved operating efficiencies and our overall efforts
to streamline operations.
DISCONTINUED OPERATIONS
- -----------------------
Loss from discontinued operations for the first six months of fiscal
2004 was $3.7 million compared to $4.1 million in the prior-year period, a
decrease in loss of $0.4 million. The decreased loss is primarily related to the
fact that several non-core businesses had been disposed of during the fiscal
2003 year. This improvement was partially offset by a $3.3 million impairment
charge on net assets related to its Middle East Operations, which was recorded
in first six months of fiscal 2004 and is included in the discontinued
operations.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
- -----------------------------------------
During the six months ended September 30, 2002, the Company, with the
assistance of independent valuation experts, completed its initial assessment
test and concluded that certain of its goodwill was impaired. Effective April 1,
2002, the Company has recognized a transitional impairment charge of $18.2
million as the cumulative effect of a change in accounting principle to reduce
the
21
carrying values of certain indefinite lived intangible assets and goodwill to
estimated fair values as required by SFAS No. 142. This is a non-cash charge and
does not impact compliance with the financial covenants contained in our lender
agreements.
NET LOSS
- --------
Net loss totaled $1.0 million for the six months ended September 30,
2003 compared to $24.0 million in the prior-year period, an improvement of $23.0
million, which was primarily attributable to non-cash goodwill impairment
charges as a result of a change in accounting principle in the prior-year,
improved revenue levels, improved operating efficiencies and our overall efforts
to streamline operations. Loss per share on a diluted basis totaled $0.11 per
share compared to $2.87 per share in the prior-year period.
B. LIQUIDITY AND CAPITAL RESOURCES
At September 30, 2003, the Company had negative working capital of
$25.2 million excluding net assets held for sale, compared to negative $28.3
million at March 31, 2003, excluding net assets held for sale, which was an
improvement of $3.1 million. This improvement is primarily attributable to
increases in accounts receivable and reductions in current debt levels. Also,
our accounts receivable increased $7.5 million primarily due to this being our
seasonally busiest time of the year.
During the first six months of fiscal year 2004, cash provided by
operating activities totaled $0.9 million compared to cash provided by operating
activities of $3.7 million in the year-earlier period. Cash used in investing
activities totaled $0.2 million during the first six months of fiscal 2004,
which included $0.3 million for capital expenditures, offset by, $0.1 million of
proceeds from the disposal of capital assets. This compares to cash used in
investing activities totaling $0.2 million during the first six months of fiscal
2003, which included $0.2 million used for capital expenditures, which was
offset by proceeds of less than $0.1 million from the disposal of capital
assets. Cash used for financing activities totaled $2.9 million, which was used
to pay down debt during the first six months of fiscal 2004 compared to cash
used by financing activities of less than $1.8 million that was used to pay down
debt in the first six months of fiscal 2003.
Revolving Credit Facility. In March 1999, the Company entered into an
$80 million revolving credit facility that originally expired on April 30, 2002
(the "Revolving Credit Facility"). Initial borrowings were used to repay
existing domestic bank indebtedness. Through a series of subsequent amendments,
including an amendment executed by the Company on November 14, 2003 and
effective as of October 31, 2003, ("November 2003 Revolver Amendment"), the size
of the Revolving Credit Facility was reduced to $27.5 million and the expiration
date was extended to January 31, 2004. Borrowings under the Revolving Credit
Facility are further limited to borrowing base amounts as defined. The Revolving
Credit Facility provides for interest on borrowings at prime plus 5.00% and
requires the Company to pay a facility fee of 1.00% on the commitment amount.
Borrowings under the Revolving Credit Facility, as amended, are secured
by the Company's domestic accounts receivable, inventories, certain intangibles,
machinery and equipment and owned real estate as well as certain assets in
Canada. The Company also has pledged slightly less than two-thirds of the
capital stock of two of its foreign subsidiaries. The Revolving Credit Facility,
as amended, requires the Company to maintain certain financial ratios and places
limitations on the Company's ability to pay cash dividends, incur additional
indebtedness and make investments, including acquisitions. At September 30,
2003, the Company had $21.9 million outstanding under the Revolving
22
Credit Facility. Total availability under the Revolving Credit Facility at
September 30, 2003 was approximately $1.3 million, after giving consideration to
the borrowing base limitations, under the Revolving Credit Facility. At
September 30, 2003, the Company was in compliance with the financial covenants
under the Revolving Credit Facility, as amended by the November 2003 Revolver
Amendment.
Under the terms of the amendments to the Revolving Credit Facility, any
cash proceeds from the disposition of targeted Company assets will be used to
reduce the Revolving Credit Facility and the Senior Notes in a ratio of 56% and
44%, respectively. Any net asset disposition payments to reduce the Revolving
Credit Facility will result in a proportionate reduction in the lender's
commitments in the Revolving Credit Facility.
In connection with the Sixth Amendment to the Revolving Credit
Facility, the lender group received a warrant ("Revolving Credit Facility
Warrant") to purchase 467,000 of the Company's common shares at a purchase price
of $0.01 per share exercisable at any time after July 31, 2003 until September
23, 2012. The Revolving Credit Facility Warrant contains a provision which
permitted the Company to reduce the amount of the Revolving Credit Facility
Warrant by up to 50% based upon prepayments of principal made by the Company
under the Revolving Credit Facility prior to July 31, 2003 with cash proceeds
received from the disposition of targeted Company assets. These prepayments
resulted in the Revolving Credit Facility Warrant being reduced by approximately
82,000 common shares at July 31, 2003.
Senior Notes. In January 1998, the Company issued, through a private
placement, $30 million of Senior Notes due 2008 (the "Senior Notes"). Through a
series of subsequent amendments, including an amendment executed by the Company
on November 14, 2003 and effective as of October 31, 2003 (the "November 2003
Senior Notes Amendment"), the terms and conditions of the Senior Notes have been
modified to, among other things, change the interest rate payable on the Senior
Notes and to defer certain principal payments thereunder. The Senior Notes, as
amended, bear interest at 11.35% until January 31, 2004. In addition, the
agreement relating to the Senior Notes (the "Senior Notes Agreement"), as
amended, provides for any overdue amount to bear an interest rate of the greater
of 13.35% or 2.00% over the rate of interest publicly announced by The Bank of
New York from time to time in New York City as its Prime Rate on the outstanding
principal payments and overdue amounts.
The Senior Notes require a principal payment of $8.7 million, which has
been deferred pursuant to the November 2003 Senior Notes Amendment to January
31, 2004, and monthly principal payments of $0.4 million, the commencement of
which has been similarly deferred until February 15, 2004 ("Notes Principal
Repayments") and are secured equally and ratably with debt under the Revolving
Credit Facility. In addition, the Senior Notes Agreement, as amended, provides
that any cash proceeds from the disposition of targeted Company assets will be
used to reduce the Revolving Credit Facility and the Senior Notes in a ratio of
56% and 44%, respectively. The Company is required to maintain certain financial
ratios under the Senior Notes Agreement. As of September 30, 2003, the Company
is currently in compliance with the financial covenants under the amended Senior
Notes Agreement.
Within the Senior Notes Agreement is a yield maintenance amount
provision, which ensures that the lender is paid the entire interest amount of
the Senior Notes. The yield maintenance amount provisions apply to certain
optional prepayments of principal under the Senior Notes and provides that the
Senior Notes shall be subject to prepayment, in whole at any time or from time
to time in part, at the option of the Company, at 100% of the principal amount
so prepaid plus interest thereon to the prepayment date and the yield
maintenance amount, if any, with respect to each Senior Note. Any partial
23
prepayment of the Senior Notes, which meet certain criteria, shall be applied
against the principal amount of the Senior Notes scheduled to become due in the
inverse order of maturity thereof. Fiscal year 2003 results include an interest
charge of approximately $1.0 million relating to the yield maintenance amount
provisions of the Senior Notes Agreement.
In connection with prior amendments in September 2002, the Senior Notes
lender received a warrant ("Senior Notes Warrant") to purchase 467,000 of the
Company's Common Shares at a purchase price of $0.01 per share exercisable at
any time after July 31, 2003 until September 23, 2012. The Senior Notes Warrant
contains a provision which permitted the Company to reduce the amount of the
Senior Notes Warrant by up to 50% based upon prepayments of principal made by
the Company under the Senior Notes prior to July 31, 2003 with cash proceeds
received from the disposition of targeted Company assets. These prepayments
resulted in the Senior Notes Warrant being reduced by approximately 82,000
common shares at July 31, 2003.
The Proposed Transaction. As previously publicly reported, the Company
has entered into a non-binding letter of intent with an undisclosed investment
firm with respect to the recapitalization and refinancing of the Company (the
"Proposed Transaction"). The Proposed Transaction is subject to a number of
conditions, including that the parties secure commitments for senior and
subordinated debt financing and that the parties enter into definitive
agreements. In addition, the proposed transaction would require approval from
the Company's shareholders as well as from the lenders under both the Revolving
Credit Facility and the Senior Notes. Each of the November 2003 Revolver
Amendment and the November 2003 Senior Notes Amendment requires the Company to
meet certain milestones related to its efforts to consummate the Proposed
Transaction, which the Company has satisfied to date. There can be no assurance
that the Proposed Transaction will be consummated, and if consummated, what the
terms for such transaction will be.
If the Company cannot successfully consummate the Proposed Transaction
on or before January 31, 2004, it will need to negotiate arrangements with its
lenders to, among other things, extend the maturity of the Revolving Credit
Facility and defer the Notes Principal Repayments beyond January 31, 2004. There
can be no assurance, however, that the Company will be able to reach acceptable
arrangements with its existing lenders or on what terms such arrangements would
be. If the Company is not able to negotiate mutually acceptable arrangements
with its existing lenders, events could occur that would have a material adverse
effect on the Company's liquidity and financial condition and could result in
its inability to operate as a going concern. If the Company is unable to operate
as a going concern, it may file, or have no alternative but to file, bankruptcy
or insolvency proceedings or pursue a sale or sales of assets to satisfy
creditors.
The following table summarized the Company's contractual obligations at
September 30, 2003:
PAYMENTS DUE BY PERIOD
-----------------------------------------------------------
LESS THAN 1 - 3 4 - 5 AFTER 5
(IN THOUSANDS) TOTAL ONE YEAR YEARS YEARS YEARS
------- ------- ------- ------- -------
Indebtedness:
Senior Notes $25,352 $25,352 $ -- $ -- $ --
Revolving Line of Credit 21,887 21,887 -- -- --
Other Debt Obligations 2,068 1,420 648 -- --
Operating Leases 6,712 2,291 3,471 750 200
------- ------- ------- ------- -------
Total Contractual Cash
24
Obligations $56,019 $50,950 $ 4,119 $ 750 $ 200
======= ======= ======= ======= =======
FACTORS INFLUENCING FUTURE RESULTS AND ACCURACY OF FORWARD LOOKING INFORMATION
This document includes certain statements that may be deemed
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
forward-looking statements are based on management's expectations and beliefs
concerning future events and discuss, among other things, anticipated future
performance and revenues, expected growth and future business plans. Words such
as "anticipates," "expects," "intends," "plans," "believes," "seeks,"
"estimates" or variations of such words and similar expressions are intended to
identify such forward-looking statements. We believe that the following factors,
among others, could affect our future performance or the price and liquidity of
our common shares and cause our actual results to differ materially from those
that are expressed or implied by forward-looking statements, or diminish the
liquidity of our common shares: our ability to further extend, amend or
refinance our existing debt, including the availability to us of external
sources of financing and capital (the failure to receive such financing would
have a material adverse effect on our results of operations and financial
condition) and the terms and timing thereof; our ability to successfully divest
our non-core and international business units and the timing, terms and
conditions of such divestitures; the ultimate outcome of the SEC's and the
Australian Securities and Investment Commission's investigation of accounting
irregularities; the impact of any litigation or regulatory process related to
the financial statement restatement process, including the class action
litigation already filed (the dismissal of which has been appealed); our mix of
products and services; the timing of jobs; the availability and value of larger
jobs; qualification requirements and termination provisions relating to
government jobs; the impact of inclement weather on our operations; the impact
of energy prices on us and our customers' businesses; adverse developments in
pending litigation or regulatory matters; the impact of existing, new or changed
regulatory initiatives; our ability to satisfy the listing and trading
requirements of the AMEX (which, if not satisfied, could result in the
suspension of trading - as occurred in August 2002 - or delisting of our shares
from the exchange, which could diminish the liquidity of our common shares) or
any other national exchange on which our shares are or will be listed or
otherwise provide a trading venue for our shares; and the impact of changing
global political and economic conditions. In addition, any forward-looking
statement speaks only as of the date on which such statement is made and we do
not undertake any obligation to update any forward-looking statements, whether
as a result of new information, future events or otherwise.
All phases of our operations are subject to a number of uncertainties,
risks and other influences, many of which are beyond our control. Any one of
such influences, or a combination, could materially affect the accuracy of the
forward-looking statements and the assumptions on which the statements are
based. Some important factors that could cause actual results to differ
materially from the anticipated results or other expectations expressed in our
forward-looking statements include the following:
OUR ABILITY TO OBTAIN EXTENSIONS, AMENDMENTS AND WAIVERS UNDER OUR DEBT
AGREEMENTS AND AVAILABILITY OF ADDITIONAL SOURCES OF FINANCING AND CAPITAL. The
Company is currently in compliance with all its financial ratios required to be
maintained under the amended debt agreements, which includes its net worth
covenant and its operating income before depreciation and amortization financial
covenant. During November of fiscal 2004, we amended our Revolving Credit
Facility and Senior Notes to extend the maturity date under the Credit Facility
and defer certain principal payments under the Senior Notes. As amended, both
the Revolving Credit Facility and the Senior Notes require that the Company meet
certain milestones related to its efforts to refinance this debt. As amended,
the Revolving Credit Facility expires on January 31, 2004, and it will be
necessary for us to amend this Revolving Credit
25
Facility to extend the expiration date. If we are unable to negotiate a further
amendment to the Revolving Credit Facility, which, among other things, extends
the maturity of the Revolving Credit Facility beyond January 31, 2004, it will
be necessary for us to refinance or repay this debt. We cannot assure that we
will be able to accomplish such a transaction on terms acceptable to us or at
all. Failure to do so would have a material adverse effect on our liquidity and
financial condition and could result in our inability to operate as a going
concern. If we are unable to operate as a going concern, we may file, or may
have no alternative but to file, bankruptcy or insolvency proceedings or pursue
a sale or sales of assets to satisfy creditors. In addition, the Senior Notes,
as amended, require a principal payment of $8.7 million by January 31, 2004 and
monthly principal payments of $0.4 million commencing on February 15, 2004. We
cannot assure that we will be able to make these payments when due, which will
result in our being in default under the Senior Notes and, in that event, the
Senior Notes lender may pursue its remedies against us for such a default,
including acceleration of principal, which would have a material adverse effect
on our liquidity and financial condition and could result in our inability to
operate as a going concern. If we are unable to operate as a going concern and
are unable to complete the proposed transaction (see below), we may file, or may
have no alternative but to file, bankruptcy or insolvency proceedings or pursue
a sale or sales of assets to satisfy creditors. If we are unable to complete the
proposed transaction, we intend to seek other financing during fiscal 2004 to
pay down the Senior Notes and the Revolving Credit Facility. There can be no
assurance, however, that we will be able to obtain other financing or as to the
terms and conditions under which such financing may be available.
The Proposed Transaction. As previously publicly reported, the Company
has entered into a non-binding letter of intent with an undisclosed investment
firm with respect to the recapitalization and refinancing of the Company (the
"Proposed Transaction"). The Proposed Transaction is subject to a number of
conditions, including that the parties secure commitments for senior and
subordinated debt financing and that the parties enter into definitive
agreements. In addition, the proposed transaction would require approval from
the Company's shareholders as well as from the lenders under both the Revolving
Credit Facility and the Senior Notes. Each of the November 2003 Revolver
Amendment and the November 2003 Senior Notes Amendment requires the Company to
meet certain milestones related to its efforts to consummate the Proposed
Transaction, which the Company has satisfied to date. There can be no assurance
that the Proposed Transaction will be consummated, and if consummated, what the
terms for such transaction will be.
If the Company cannot successfully consummate the Proposed Transaction
on or before January 31, 2004, it will need to negotiate arrangements with its
lenders to, among other things, extend the maturity of the Revolving Credit
Facility and defer the Notes Principal Repayments beyond January 31, 2004. There
can be no assurance, however, that the Company will be able to reach acceptable
arrangements with its existing lenders or on what terms such arrangements would
be. If the Company is not able to negotiate mutually acceptable arrangements
with its existing lenders, events could occur that would have a material adverse
effect on the Company's liquidity and financial condition and could result in
its inability to operate as a going concern. If the Company is unable to operate
as a going concern, it may file, or have no alternative but to file, bankruptcy
or insolvency proceedings or pursue a sale or sales of assets to satisfy
creditors.
THE EFFECTIVENESS OF OUR BUSINESS RESTRUCTURING PLAN. In July 2002, our
Board of Directors approved a formal business restructuring plan. The multi-year
plan includes a series of initiatives to improve operating income and reduce
debt. We intend to sell non-core business units and use the proceeds to reduce
debt. While we expect that operating income improvements combined with debt
reduction will result from the business restructuring plan in the long term, it
is uncertain at this time to
26
what extent such operating income improvements and debt reduction will be
achieved as a result of the business restructuring plan and the terms and/or
timing thereof. We cannot assure that the business restructuring plan will be
successful in enhancing our ability to pursue financing alternatives acceptable
to us. During fiscal 2004 our Asia Pacific Operations was sold and in fiscal
2003, we sold four non-strategic business units. The fiscal 2003 dispositions
included Rohrback Cosasco Systems, Bass Trigon Software and two smaller
international offices. The proceeds from these dispositions were used to pay
down debt. For further information about our discontinued operations see Note 2,
Assets and Liabilities Held for Sale, Notes to Consolidated Financial Statements
included in Item 8 of our Form 10-K.
OUR REPUTATION AND FINANCIAL CONDITION COULD BE AFFECTED BY THE
SECURITIES LITIGATION AND RELATED INVESTIGATIONS AND/OR A RESTATEMENT OF
FINANCIAL STATEMENTS. On March 20, 2002, we first announced that we had become
aware of accounting irregularities caused by apparent internal misconduct in our
Australian subsidiary and that, to the extent that the accounting irregularities
materially affect previously filed financial statements, we restated our audited
financial statements for our fiscal year which ended March 31, 2001 as well as
unaudited financial information for the first nine months through December 31,
2001 of our fiscal year ended March 31, 2002, as previously released. In
addition, we recorded a charge to earnings for our loss on investment related to
the subsidiary. This charge was taken in the Company's fiscal fourth quarter
ended March 31, 2002. Subsequent to this announcement, a purported class action
lawsuit was filed against us and certain of our current and former directors and
officers, asserting claims under the federal securities laws, which was
dismissed with prejudice in May 2003. In June 2003, the plaintiffs filed a
notice of appeal from the order of dismissal. In addition to significant
expenditures we may have to make to defend ourselves in these matters and the
related significant financial penalties that might be imposed on us if the
plaintiffs prevail, the publicity surrounding the litigation and the SEC inquiry
of these matters could affect our reputation with our customers and suppliers
and have an impact on our financial condition and results of operations.
OUR COMPLIANCE WITH THE LISTING STANDARDS AND REPORTING REQUIREMENTS OF
THE STOCK EXCHANGE ON WHICH OUR COMMON SHARES TRADE. We are required by the
stock exchange on which we list our common shares for trading to maintain
certain listing standards and meet certain reporting requirements in order to
continue trading and to remain listed on that exchange. In September 2003, we
received a notice from the American Stock Exchange confirming that as of June
30, 2003 we did not have a sufficient amount of shareholders' equity to meet its
guidelines. We have since submitted a plan to the American Stock Exchange that
we believe demonstrates our ability to meet or exceed the required listing
standards, however, if we cannot demonstrate that we will be in compliance
within 18 months of June 30, 2003, our common shares may not be allowed to trade
on the stock exchange. In such case, we would pursue an alternative trading
venue although it may make it more difficult for us to raise funds through the
sale of our securities. In addition, it may make it more difficult for an
investor to dispose of, or to obtain accurate quotations of, our common shares
and negatively impact the market price. Our shares had been suspended from
trading on the American Stock Exchange in August 2002, because of, among other
reasons, the late filing of our Form 10-K/A for the fiscal year ended March 31,
2002. There can be no assurances that our shares will not be delisted or that
trading will not be suspended again and if so, that trading would be permitted
to resume.
ADVERSE DEVELOPMENTS IN PENDING LITIGATION OR REGULATORY MATTERS. From
time to time, we are involved in litigation and regulatory proceedings,
including those disclosed in "Legal Proceedings" of our annual report on Form
10-K and in our other periodic reports filed with the Securities and Exchange
Commission. There are always significant uncertainties involved in litigation
and regulatory proceedings and we cannot guarantee the result of any action.
Regulatory compliance is often complex
27
and subject to variation and unexpected changes, including changing
interpretations and enforcement agendas affecting the regulatory community. We
may need to expend significant financial resources in connection with legal and
regulatory procedures and our management may be required to divert attention
from other portions of our business. If, as a result of any proceeding, a
judgment is rendered, decree is entered or administrative action is taken
against us or our customers, it may materially and adversely affect our
business, financial condition and results of operations.
OUR PROFITABILITY CAN BE IMPACTED BY OUR MIX OF PRODUCTS AND SERVICES.
Given that our selling, general and administrative costs are largely fixed in
terms of dollars, our profitability is dependent upon the amount of gross profit
that we are able to realize. We typically generate higher gross profit margins
on pure engineering service jobs than on those jobs that include a material or
installation component. In addition, our gross profit margins also can be
negatively impacted when we utilize subcontractors. Therefore, a shift in mix
from engineering services to more construction and installation type work or an
increase in the amount of subcontracting costs could have a negative impact on
our operating results. In addition, certain of the products that we sell have
gross profit margins that are considerably lower than our overall average gross
profit margin. A shift in mix which results in a greater percentage of revenues
relating to these lower margin products would also have a negative impact on our
operating results.
THE TIMING OF JOBS CAN IMPACT OUR PROFITABILITY. There are a number of
factors, some of which are beyond our control, that can cause projects to be
delayed and thus negatively impact our profitability for the related period.
These factors include the availability of labor, equipment or materials,
customer scheduling issues, delays in obtaining required permits and weather. In
addition, when we are working as a subcontractor on a project, our portion of
the project can be delayed as a result of factors relating to other contractors.
THE AVAILABILITY AND VALUE OF LARGER JOBS CAN IMPACT OUR PROFITABILITY.
While the majority of our jobs are relatively small, we can have a number of
individual contracts in excess of $1 million in progress at any particular time.
These larger contracts typically generate more gross profit dollars than our
average size jobs. Therefore, the absence of larger jobs, which can result from
a number of factors, including market conditions, can have a negative impact on
our operating results.
QUALIFICATION REQUIREMENTS AND TERMINATION PROVISIONS RELATING TO
GOVERNMENT JOBS. We derive revenues from contracts with the United States, its
agencies and other governmental entities. Government contracting is subject to
competitive bidding processes and there can be no assurance that we will be the
successful bidder for future contracts. Fluctuations in government spending and
the amount of government contracts received also could adversely affect our
revenues and profitability. In addition, it is the policy of the United States
that certain small businesses and other concerns have the maximum practicable
opportunity to participate in performing contracts let by any federal agency. To
the extent that we do not meet applicable criteria for government jobs, we could
be limited in our ability to participate directly in contracts being let by the
United States and other governmental entities with similar requirements. Certain
contracts with governmental entities contain provisions permitting the
governmental entities to terminate the contract for convenience prior to
completion of the contract. To the extent that any of our contracts with a
government entity are so terminated, our revenues and profitability could be
adversely impacted.
OUR OPERATIONS CAN BE IMPACTED BY INCLEMENT WEATHER. A large portion of
our service work is performed in the field. Therefore, excessive amounts of
rain, snow or cold, as well as other unusual weather conditions, including
hurricanes and typhoons, can result in work stoppages. Also, working under
inclement weather conditions can reduce our efficiencies, which can have a
negative impact on
28
our profitability.
OUR BUSINESS IS IMPACTED BY CHANGES IN ENERGY PRICES. The products and
services we provide to our customers in the energy markets are, to some extent,
deferrable in the event that these customers reduce their capital and
discretionary maintenance expenditures. The level of spending on these types of
expenditures can be influenced by oil and gas prices and industry perceptions of
future prices. Our experience indicates that our energy customers react to
declining oil and gas prices by reducing their capital and discretionary
maintenance expenditures. This reaction has in the past, and may in the future,
have a negative impact on our business. We are unable to predict future oil and
gas prices. However, we believe that a prolonged period of low energy prices
could have a negative impact on our business. Typically, there is a delay
between the time prices decline and when we start to experience a negative
impact on our results of operations. Conversely, there is also a delay between
the time energy prices increase and when we start to experience a positive
impact on our results of operations.
THE IMPACT OF CHANGING GLOBAL, POLITICAL AND ECONOMIC CONDITIONS.
Changing political and economic conditions regionally or worldwide can adversely
impact our business. Deteriorating political and general economic conditions may
result in customers delaying or canceling contracts and orders for our products
and services, difficulties and inefficiencies in the performance of our services
including work stoppages, and difficulties in collecting payment from our
customers. As a result, such conditions can negatively impact our results of
operations and our cash flows. Moreover, we have operations in the Middle East
region with revenues totaling $6.1 million for the six months of fiscal 2004 and
net assets of approximately $2.6 million at September 30, 2003. These operations
can be negatively impacted by changing economic and political conditions. All of
our international operations except Canada and our European Operations are a
part of the Company's net assets held for sale.
EXISTING, NEW OR CHANGED REGULATORY INITIATIVES CAN IMPACT OUR
BUSINESS. Corrpro and its customers are subject to federal, state and local
environmental and other laws and regulations. These laws and regulations affect
our operations by imposing standards for the protection of health, welfare and
the environment. Such laws and regulations, and applicable interpretations
thereof, could expose us to liability for acts which are or were in compliance
at the time such acts were performed. We cannot predict whether future
legislative or regulatory developments may occur which would have an adverse
effect on Corrpro.
These risks must be considered by any investor or potential investor in
the Company.
C. CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States.
As such, some accounting policies have a significant impact on amounts reported
in these financial statements. A summary of those significant accounting
policies can be found in the Company's fiscal 2003 Annual Report on Form 10-K,
filed on June 30, 2003, in the Note 1 - Summary of Significant Accounting
Policies, Notes to Consolidated Financial Statements, and under the caption
"Significant Accounting Policies" within Management's Discussion and Analysis of
Financial Condition and Results of Operations. In particular, judgment is used
in areas such as revenue recognition for construction and engineering contracts,
determining the allowance for uncollectible accounts and inventory valuation
reserves, asset impairment and deferred tax assets.
29
D. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB")
issued FASB Interpretation No. ("FIN") 46, "Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51." This Interpretation addresses the
consolidation by business enterprises of various interest entities as defined in
the Interpretation. The provisions of FIN 46 are effective on February 1, 2003
for all variable interest entities created after January 31, 2003. For all
variable interest entities created prior to February 1, 2003 the provisions of
this statement are effective for periods ending after December 31, 2003. The
Company does not expect the adoption of this Interpretation to have a material
impact on its results of operations or financial position.
In April 2003, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities." This statement amends SFAS No. 133 for
decisions made (1) as part of the Derivatives Implementation Group process that
effectively required amendments to SFAS No. 133, (2) in connection with other
FASB projects dealing with financial instruments and (3) in connection with
implementation issues raised in relation to the application of the definition of
a derivative. This statement is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003, with certain exceptions. The adoption of SFAS No. 149 did not have a
material impact on the results of operations or financial position of the
Company.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments and Characteristics of both Liabilities and Equity" which
requires freestanding financial instruments such as mandatorily redeemable
shares, forward purchase contracts written put options to be reported as
liabilities by their issuers as well as related new disclosure requirements. The
provisions of SFAS No. 150 are effective for instruments entered into or
modified after May 31, 2003 and pre-existing instruments as of the beginning of
the first interim period that commences after June 15, 2003. The application of
this Statement did not have an effect on the Company's consolidated financial
statements.
30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- -------
MARKET RISK DISCLOSURES
In the normal course of business, our operations are exposed to
continuing fluctuations in foreign currency values and interest rates that can
affect the cost of operating and financing our business.
INTEREST RATE RISK
Our primary interest rate risk exposure results from our variable
interest rate Revolving Credit Facility, Senior Notes and various smaller lines
of credit that we maintain with foreign banks. If interest rates were to
increase 200 basis points (2%) from the rates at September 30, 2003 rates, and
assuming no changes in debt from the September 30, 2003 levels, the additional
annual expense would be approximately $1.0 million on a pre-tax basis.
FOREIGN OPERATIONS AND FOREIGN CURRENCY EXCHANGE RISK
Our foreign subsidiaries generally conduct business in local
currencies, creating foreign exchange risk. During the first six months of
fiscal 2004, the Company recorded a favorable foreign currency translation
adjustment of $0.9 million related to net assets located outside the United
States. This foreign currency translation adjustment resulted primarily from the
weakening of the United States Dollar in relation to the Canadian Dollar and the
British Pound. We do not enter into derivatives to hedge foreign currency
exchange risk. Our foreign operations are also subject to other customary risks
of operating in a global environment, such as unstable political situations, the
effect of local laws and taxes, tariff increases and regulations and
requirements for export licenses, the potential imposition of trade or foreign
exchange restrictions and transportation delays.
31
ITEM 4. CONTROLS AND PROCEDURES
- -------
(b) Evaluation of Disclosure Controls and Procedures.
The Company's Chief Executive Officer and Chief Financial Officer (the
"Senior Officers"), with the participation of other members of the Company's
management, have evaluated the effectiveness of the Company's disclosure
controls and procedures as of September 30, 2003. Based on that evaluation, the
Senior Officers have concluded that, as of September 30, 2003, the Company's
disclosure controls and procedures are effective in ensuring that information
required to be disclosed by the Company is recorded, processed, summarized and
reported within the time periods specified in the SEC's rules and forms. There
were no changes in internal controls that occurred during the Company's most
recent fiscal quarter that have materially affected, or are reasonably likely to
affect, the Company's internal controls.
32
PART II. OTHER INFORMATION
- ---------------------------
ITEM 1. LEGAL PROCEEDINGS
- -------
As previously reported, in January 2000, the Michigan Department of
Environmental Quality ("MDEQ") issued an administrative decision which
effectively limited the scope of MDEQ's 1995 approval of certain assessment
methodologies utilized by Corrpro in determining whether certain underground
storage tanks meet Michigan's regulatory requirements for upgrade by means of
cathodic protection. The MDEQ decision also would have required us to conduct
further assessments and provide certain information. The assessment
methodologies at issue have been and remain recognized by the Environmental
Protection Agency ("EPA") and the other states in which we utilized such
methodologies for virtually identical purposes. We believed that MDEQ's decision
was in error and on January 24, 2000, filed a complaint and claim of appeal in
the Circuit Court for the County of Ingham, Michigan seeking declaratory relief
and appealing the decision on several grounds. In its November 14, 2000 ruling,
the Ingham Circuit Court reversed MDEQ's decision that directed we take certain
actions and provide certain information, however, the court also found that MDEQ
had not approved the full use of the assessment methodologies we utilized in
Michigan.
We believed that the circuit court's finding that MDEQ had not approved
full use of the methodologies was not supported by the evidence, and was
contradicted by evidence contained in the administrative record. On December 5,
2000, we filed, in the Michigan Court of Appeals, an application for leave to
appeal the circuit court's finding that MDEQ did not approve the full use of the
assessment methodologies we utilized in Michigan. By order dated February 14,
2001, the Michigan Court of Appeals denied our application for leave to appeal
the circuit court's finding. On March 7, 2001, we filed an application for leave
to appeal with the Supreme Court of the State of Michigan. On August 28, 2001,
the Michigan Supreme Court denied our application for leave to appeal.
As a result of these proceedings, the MDEQ's administrative decision
finding that certain of our assessment methodologies were not approved in full
was upheld, but the MDEQ was found not to have jurisdiction to enforce its
decision against us. In July 2002, the MDEQ sent certain underground storage
tank owners and operators who may have relied on our method of assessment a
notice informing them that certain of such owners and operators' tanks were
improperly upgraded, that such owners and operators are to provide to MDEQ upon
request evidence that they have conducted state required tank tightness testing,
and certain of such tanks must be internally inspected. MDEQ also advised that
internally inspected tanks that do not satisfy applicable criteria should be
taken out-of-service and removed from the ground.
On July 25, 2002, a summons and complaint was issued from the Circuit
Court for the County of Ingham, Michigan. The action was commenced by Blogett
Oil Company, Inc. and other owners and operators of underground storage tanks
systems on behalf of themselves and others similarly situated. The complaint
relates to the MDEQ regulatory proceeding described immediately above and names
both the Company and MDEQ. The plaintiffs seek an unspecified amount of damages
in excess of $25,000 from Corrpro. The plaintiffs also seek injunctive relief
prohibiting the MDEQ from declaring that underground storage tanks upgraded by
the Company do not meet the current requirement for corrosion protection set
forth by law. On November 18, 2002, the court issued an order certifying the
underlying class. The Michigan Court of Appeals denied the Company's application
for leave to appeal the Circuit Court's order certifying the underlying class.
By letters dated July 7, 2003 and thereafter, the MDEQ issued a notice to
certain owners and operators of tanks upgraded based on the Company's assessment
method that they had until October 7, 2003 to comply with certain actions
specified in the MDEQ's
33
notice. In October 2003, the Company and a steering committee representing the
class of plaintiffs reached an agreement, subject to court approval, pursuant to
which the class of plaintiffs would agree to settle all outstanding matters
between the class and the Company and to dismiss the case as to the Company with
prejudice. On October 29, 2003 the Circuit Court for the County of Ingham,
Michigan approved the settlement and dismissed with prejudice the litigation as
to the Company. The settlement amount itself was funded pursuant to applicable
policies of insurance maintained by the Company.
During fiscal 2001, the Company discovered that a former employee used
an incorrect assessment standard in connection with the evaluation of whether
certain underground storage tanks located at as many as 67 sites were eligible
for upgrade using cathodic protection. Such evaluations were done using one of
the approved assessment methodologies. The tanks at these sites, which are
located in five states, were subsequently upgraded using cathodic protection,
which arrests corrosion. These tanks are also subject to ongoing leak detection
requirements. Based on the Company's review of available information and
governmental records, the Company believes that there have not been any releases
from the affected tanks as a result of the actions of the former employee. The
Company has contacted, and in October and November 2000 met with, officials from
the EPA and officials from the corresponding environmental protection agencies
of the five states involved to discuss this matter. It is the Company's
understanding that none of the states nor the EPA intend to take any enforcement
action as a result of the use of the inaccurate standard by the former employee.
The Company is currently working with the states and the EPA to develop and
implement field investigation procedures to assess the current status of the
affected sites. Based on currently available information, the Company does not
believe that the cost of field investigation procedures for this matter will
have a material effect on the future operations, financial position or cash
flows of the Company.
The Company is a defendant in a purported class action suit filed on
June 24, 2002, in the United States District Court, Northern District of Ohio,
Eastern Division. The complaint also names certain former and current officers
and directors of the Company as defendants. The complaint was purportedly filed
on behalf of all persons who purchased Corrpro Common Shares during the period
April 1, 2000 through March 20, 2002 and alleges violations of the federal
securities laws resulting in artificially inflated prices of the Company's
Common Shares during the class period. The complaint relates to the Company's
announcement that it had discovered accounting irregularities caused by apparent
internal misconduct in its Australian subsidiary. The complaint seeks
unspecified compensatory damages, fees and expenses on behalf of the putative
class. On or about May 27, 2003, the District Court granted, with prejudice, the
defendants motions to dismiss the amended and consolidated class action
complaint. On June 24, 2003, the plaintiffs filed a notice of appeal to the
United States Circuit Court of Appeals for the 6th Circuit from the order of
dismissal. The Company is unable at this time to make a determination as to
whether an adverse outcome is likely and whether an adverse outcome would have a
materially adverse affect on its operations or financial condition.
Company management discovered accounting irregularities at the
Australian subsidiary in early calendar 2002 and upon discovery immediately
began an internal investigation, which has been conducted under the direction of
the Audit Committee of its Board of Directors. The Australian Securities and
Investments Commission has commenced an independent investigation of the
accounting irregularities. Corrpro voluntarily disclosed this matter to the SEC,
which has commenced a formal inquiry. Corrpro is cooperating with both
commissions.
In January 2003, the Company received a Consolidated Compliance Order
and Notice of Potential Penalty from the Louisiana Department of Environmental
Quality pursuant to which the department alleges that the Company's foundry
operations failed to submit required storm water
34
monitoring information as required by law. The alleged failure relates to
periods subsequent to the cessation of the Company's foundry operations. The
Company has appealed the matter and the department has agreed to engage an
informal resolution of the matter. Based on current available information, the
Company does not believe that this matter will have a material effect on the
future operations, financial position or cash flows of the Company.
The Company is subject to other legal proceedings and claims which
arise in the ordinary course of business.
35
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. See the Exhibit Index at the last page of this Form 10-Q.
B. Reports on Form 8-K
1. On July 9, 2003, the Registrant furnished a Report on Form
8-K, reporting under Items 7 and 9 thereof the announcement of
the operating and financial results for its fiscal year ended
March 31, 2003.
2. On July 18, 2003, the Registrant filed a Report on Form
8-K, reporting under Items 7 and 9 thereof of the announcement
of the sale of its Asian operations.
3. On August 4, 2003, the Registrant filed a Report on Form
8-K, reporting under Items 7 and 9 thereof the status of the
negotiations with its senior lenders, and the mailing of its
2003 annual report to shareholders.
4. On August 14, 2003, the Registrant filed a Report on Form
8-K, reporting under Items 5 and 7 thereof that its bank debt
maturity was extended and senior note amortization was
rescheduled.
5. On August 20, 2003, the Registrant furnished a Report on Form
8-K, reporting under Item 12 thereof the announcement of the
operating and financial results for the fiscal quarter ended
June 30, 2003.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CORRPRO COMPANIES, INC.
(Registrant)
Date: November 14, 2003 /s/ Joseph W. Rog
------------------------------------
Joseph W. Rog
Chairman of the Board, President
and Chief Executive Officer
/s/ Robert M. Mayer
-------------------------------------
Robert M. Mayer
Senior Vice President, Chief
Financial Officer
37
EXHIBIT INDEX
-------------
Exhibit
No. Exhibit
--- -------
10.1 Form Of Amendment To Executive Officer Employment Agreement By And
Between The Company And Certain Executive Officers And Schedule
Thereto.
10.2 Amendment To November 2000 Agreement By And Between Corrpro Companies,
Inc., Commonwealth Seager Holdings Ltd, Corrtech Consulting Group, and
Barry W. Schadeck.
10.3 Consulting Agreement dated April 1, 2003 by and between Commonwealth
Seager Holdings Ltd. and Corrtech Consulting Group.
31.1 Rule 13a-14(a) Certification Chief Executive Officer
31.2 Rule 13a-14(a) Certification Chief Financial Officer
32.1 Section 1350 Certification Chief Executive Officer
32.2 Section 1350 Certification Chief Financial Officer
38